Fight the Spanish heat with Mexico’s Femsa

Jon D. Markman writes the “Speculations” column for MarketWatch. He is an
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Data coursing through the veins of the global economy has been turning a darker shade of blah in recent weeks as a result of a widening recession in Europe and a dull malaise settling over the United States, making stocks more vulnerable to shocks.

If I knew exactly what those shocks were, by definition they would not be shocks. But possibilities include a full-blown economic collapse in Spain that leads to paralysis across South America and other emerging markets.

We care about Europe because the region's banks play such an important role in world finance. True fact, according to research from hedge fund veteran Craig Drill: While the European Union only represents 18% of world GDP, its banking system accounts for 42% of global bank assets.

That is much more than all of North America (Canada and the United States), which account for only 16.2% of global bank assets, or Japan, at 10.4%. Now you get the picture? Europe, the original colonizer, finances the world.

One reason European banks have suffered more than U.S. banks is that their health is tied so closely to that of their home-country governments. A vast majority of their Tier 1 capital is held in the form of their government's debt. This is why the contagion effect is so real when talking about these banks.

Banco Santander
STD, -1.38%
as an example, is a major international bank based in Spain that is extremely important in the financing of South America. As its fortunes wane, it drags down international branches too, blunting their ability to extend loans needed for growth.

So is all lost among companies in the greater Spanish sphere of influence? Definitely not.

One of my favorite stocks in the world right now is actually based in Mexico. Its formal name is Fomento Economico Mexicano SABFMX, +0.10%
but it is typically known by its acronym F-E-M-S-A.

Femsa is a $150 billion integrated beverage firm based in Monterrey, Mexico. It owns a 54% stake in Coca-Cola FemsaKOF, +1.87%
the largest Coke bottler in Latin America as well as a 20% ownership stake in Dutch brewer Heineken.

To further expand its diversification, Femsa also owns the Oxxo chain of convenience stores, which consist of 9,500 units across Mexico and Colombia. The stores are already Mexico's largest convenience store chain, and analysts expect another 3,000 stores over the next couple of years.

Femsa's reach is impressive to say the least, with over 177,000 employees, over 160 beverage brands, 9,300 distribution routes, and a couple of hundred soft drink and store distribution facilities. All this equates to nearly $15 billion in annual revenues across nine Latin American nations.

Femsa 's history dates back to 1890, when a group of entrepreneurs founded a brewery called Cerveceria Cuahtemoc in Mexico. Its first brand of beer was Carta Blanca, which became wildly popular and is still one of the best selling brands in the country.

In 1985, Femsa merged its brewery with the Moctezuma breweries, allowing the combined company to maintain the leading position in the domestic market, while adding some of Femsa 's fiercest competition to its own portfolio. At the height of its beer operations, Femsa was the second-largest brewer in Mexico, producing brands known around the world such as Tecate, Sol, Dos Equis, and Indio.

However, in a bold and aggressive move in 2010, Femsa put its entire beer business up for auction in an attempt to focus on its faster growing soft drink and convenience businesses. The auction drew a lot of attention, but Heineken had the top bid, pledging an equivalent of $7.6 billion in an all-share deal.

Heineken was keen on expanding its emerging market exposure, and the deal now placed it as the #2 firm in the fourth largest beer market in the world. Meanwhile, Femsa could focus on its other core businesses, while still profiting from the growth of beer, as the deal gave them a 20% share of Heineken.

Femsa can achieve a level of efficiency neither its beverage nor retail peers can match. The company's vertically integrated business strategy allows it to control every aspect of the supply chain, from beverage production to distribution to retailing.

The firm leverages its convenience stores to prioritize its own beverage brands ahead of others. Additionally, Oxxo is Coca-Cola Femsa's largest customer and a growing percentage of Heineken sales.

The firm has continued to expand its brand and business reach, as subsidiary Coca-Cola Femsa announced in 2010 that it signed an agreement to acquire all the shares of Grupo Industrias Lacteas in Panama. This deal would allow the company to enter the milk and dairy products category and further expand its non-alcoholic beverage business.

Currently, Femsa caters to over 1.7 million retailers and 215 million consumers, and is the number one beverage provider in every region that it operates in. The firm has grown revenues by 16% annually for the last 10 years, including a +20% gain in 2011.

The Oxxo convenience store division represents just over a third of total sales, and Femsa opens a new store every eight hours on average, serving close to eight million people daily. Store growth has been steady at 19% annually since 2000, and here's a factoid for the water cooler: Oxxo is the largest store chain in the Americas, even ahead of the likes of 7-Eleven.

The company has a solid foothold on the beverage and convenience store markets, thus the biggest risk to it is economic. Strengthening of the U.S. dollar vs. the Mexican peso is detrimental as the firm's debt is held dollar denominated, as well as a portion of the raw materials it purchases.

Shares are up 22% on the year and trading at 21x next year's earnings, but Femsa is a growth stock by most measures, and historically trades at a premium to its slower growing peers. Looks like a keeper. Buy on $5 to $10 dips. Bottom's up.

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